Why is National Debt Bad? How to Prepare for the Future
The world is drowning in debt. A historically low-interest rate and an aloof political class have led to a level of indebtedness rarely before seen.
So why is national debt bad?
In this article, we’ll provide a comprehensive overview of what national debt is, whether it’s good or bad, what the second-order effects are and how you can protect yourself from the inflation that’s likely to result from indiscriminate government spending.
National Debt Definition
In a sentence: national debt is how much a government owes to its citizens and/or foreign investors (although increasingly governments owe a debt to themselves as Federal banks monetize deficit spending. More on this later).
Just a refresher on the basics, a government creates new debt by issuing a treasury. The holders of that treasury earn a certain amount of interest-based on the risk that they’re taking.
Because investors feel that the USA is a low credit risk, the rate on US treasuries is quite low. For example, on August 26, 2020, an American 10-year treasury bond came with a 0.65% yield.
Nations perceived as more likely to default must pay more to entice investors to buy their debts. A 10-year Russian government bond yields 6.21% — 9 times more than an American bond.
One reason the United States is so in debt is that they’ve been able to issue trillions of dollars’ worth of debt inexpensively. If you have a 0% interest credit card, it’s tempting to spend on it, whereas if the interest rate is 20%, you’ll probably be much more careful with your purchases.
Causes of National Debt
National debt is simply something that happens when governments spend more than they make. There are nearly unlimited reasons why this might happen. Here are two big ones.
Wars are a major cause of national debt. After World War Two, the United States and much of Europe were heavily indebted. The Vietnam War at least partially contributed to America’s breaking with the gold standard. More recently, America’s intervention in Iraq is estimated to have cost $1.9 trillion (we’re not even considering Afghanistan).
Besides war, other big causes of debt are underfunded social programs. Pensions, subsidized gasoline, subsidized electricity, subsidized healthcare, etc. All those things that governments do to keep their citizens happy.
These programs cost money. And if a government isn’t bringing in enough from taxes to cover the cost, they’ll often take on debt to continue funding the program.
Stability. If you read the headlines you’ll find that the cause for a surprising number of riots, revolutions, and civil unrest is a cut to social programs.
The Effects of National Debt on the Economy
The effect of national debt on an economy isn’t necessarily bad. Take this example. Country A borrows $50 billion to modernize its manufacturing sector. They upgrade the electrical grid, rebuild the roads, and build a new port so that they can ship their products overseas.
Due to an increase in productive capacity, the country’s GDP (value of goods and services a country produces) goes up, they pay off the debt, and they’re now a more prosperous nation as a result of having incurred some debt.
When used for investment, national debt can be a good thing. Where debt becomes a problem, and when it begins to negatively affect an economy, is when debt is used to pay for everything.
As national debt increases, a country must pay to service it. That is, they must make payments on both the interest and principal. The result of these payments is that less money is available to pay for everything else.
Say hello to Joe Freedom who has an income of $1,000 per month. If Joe is paying $300 for his mortgage and $200 for his car loan, after debt payments, he only has half his disposable income left each month for other purchases.
The same thing can happen on a national level, whereby a country must make so many payments on its debt that it doesn’t have much income left over for other things.
This can create a problematic loop whereby a country heavily in debt must take out more debt to pay for unexpected expenses (like war, hurricanes, droughts, striking teachers, etc.). The debt loop is not a happy loop.
When National Debt Becomes a Problem
National debt becomes a problem once it becomes so large that a country cannot afford to pay for other essential services. Greece is a great example.
Greece is so indebted to the IMF that its economy is essentially crippled. They’ve had terrible austerity measures forced upon them to free up cash to pay their creditors. Let’s look at how they stack up compared to a few other countries.
Greece has a national debt to GDP ratio of 176%. That is, their national debt is 1.7 times the size of their GDP, or total economic output. As of writing, the debt to GDP ratio for the United States is 106% (owing to COVID stimulus spending these numbers are rapidly rising).
Germany, Greece’s largest creditor nation, has a government debt to GDP ratio of just 59%. Their GDP is actually larger than their debt and it’s been shrinking for years.
In determining when national debt becomes a problem, we must consider a variety of factors. Productivity, GDP, currency strength, military strength, soundness of the political class, etc. All of these factors and more contribute to a country’s ability (or inability) to take on debt without it harming the economy.
The United States can sustain a high level of national debt because the dollar is the world’s reserve currency (plus they have a walloping military and a long history of repayment). If a country like Vietnam tried to issue as much debt as America (currently Vietnam’s debt to GDP ratio is 57%), it might become a problem.
US National Debt
The national debt of the United States has been growing steadily since the gold standard was dismissed in 1971. Many economic factors have changed since 1971, a point well illustrated by the website: wtfhappenedin1971.com
Looking back at the last 50 years, we can see that the debt to GDP ratio for the USA bottomed sometime around 1982 at about 35%. Since then, it has been steadily growing with a noticeable jump right after the Great Financial Crisis (GFC). By 2010 the national debt had grown to 100% and has never yet gone below that level.
How did the USA become so indebted? In simplest terms, the United States has continually spent more than it’s taking in from taxes. In recent history, President Trump’s tax cuts significantly reduced revenue, leading to a further increase in the yearly deficit. In 2019, America’s budget deficit was $1 trillion.
How does all this debt affect the economy? As debt payments pile up, there is less money available for other programs (interest payments alone on American debt are $479 billion per year).
Debt can also be deflationary. To pay the debt, the government must increase taxes; and more taxes mean that people have less money to spend in the real economy and less spending leads to deflation.
However, a deflation hypothesis is based on the assumption that the debt is going to be repaid. It’s not, at least not in real terms. Here are the three ways out of debt for the USA.
- Default - The United States will not default as it would ruin its credibility.
- Pay back the debt - Doubtful given the amount of debt the US has.
- Inflate the debt away - The most likely option by far. The USA has a printing press it can use to devalue the dollar, which means the US’ dollar-based debt gets easier to repay.
So in nominal terms, the United States will pay back its debt. However, the inflated dollars will be worth far less than when the debt was issued. The result? The American government might only end up paying back $0.25 on the dollar in real terms (or $0.50 or $0.05, who can say).
Inflating the debt away doesn’t happen overnight, though, and the question we must address now is: what effect does an unpayable debt have on the economy? Will inflation be manageable or a mess?
Answering that question is difficult as we’re moving into uncharted territory. The United States is approaching a level of indebtedness, in both nominal terms as well as in terms of percentage of GDP, that has never been seen before.
How to Defend Against National Debt
People who understand the risk of inflation, the risk of failing currencies outside of the United States, the risk of hyperinflation in weaker economies, these are the people buying Bitcoin and gold, both of which have limited supplies (fixed in the case of Bitcoin) and can’t be printed endlessly.
The USA had an unpayable debt before COVID. Post-COVID, America’s indebtedness will be so massive that the very notion of ever paying it off will be a joke, not a serious proposal at Congress. That is an economic reality that could easily be something less than fun to live with.
Paul Tudor Jones, Luke Gromen, Raoul Pal, Dan Tapiero, Dan Morehead, Jeff Booth, Preston Psych, Mark Yusko, etc. These are just a few of the very smart men talking about Bitcoin and gold as a hedge against an uncertain economic future.
The dollar won’t collapse, but the Euro sure isn’t looking so hot. The dollar won’t inflate out of existence altogether but other currencies with their own debts will.
BTC and Gold are an insurance policy against the monetary madness afflicting the world. National debt around the world has been growing for decades and accelerating in the last decade. At some point, the elephant in the room is going to get belligerent.
While we might not be able to directly influence the amount of debt our countries have, we can at least prepare for the potential consequences by buying inflation-proof assets like Bitcoin and gold.
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This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.